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Chapter 10

Microeconomics - Chapter 10.docx

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McMaster University
Rita Cossa

Microeconomics – Chapter 10 (Externalities) Externality – The uncompensated impact of one person’s action on the well-being of a bystander - Can be negative or positive, depending on whether the impact is adverse of beneficial - Self-interested buyers/sellers neglect external costs/benefits , making market output inefficient - Public policies can improve efficiency in the presence of externalities Private Cost – Cost directly incurred by sellers (Supply curve) Private Value – Value to buyers, and amount they are willing to pay (Demand curve) External Cost – Value of negative impacts on bystanders Social Cost – Private and external costs added together - When market participants must pay social costs, Market equilibrium = Social optimum Internalizing an Externality – Altering incentives so that producers take account of the external effects of their actions - Negative externality  Market quantity larger than socially desirable - Tax goods with negative externalities - Positive externality  Market quantity lower than socially desirable - Subsidize goods with positive externalities Private Value – The direct value to buyers External Benefit – Value of the positive impact on bystanders Social Value – Private value and external benefits added together - New socially optimal quantity maximizes welfare: - At any lower quantity, the social value of additional units exceeds the cost - At any higher quantity, the cost of the last unit exceeds its social value Command-and-control Policies – Regular behaviour directly - Limit on quantity of pollution emitted - Firms have to adopt a particular technology to reduce emissions Market-based Policies – Provides incentives so that private decision makers solve their own problem - Ex. Corrective taxes and subsidies - Tradable pollution permits - Protect environment at a lower cost to society than direct regulation Corrective Taxes
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